Government Contracts Quarterly Update - July 2014

The Government Contracts Quarterly Update is published by BakerHostetler’s Government Contracts Practice team to inform our clients and friends of the latest developments in federal government contracting.

Topics will include:

- Proposed Rule Focuses on Audit of Business Systems, May Expedite and Streamline Process

- Excerpt from Proposed Rule Focuses on Audit of Business Systems, May Expedite and Streamline Process:

On July 15, the Department of Defense (“DOD”) released a proposed rule, 79 Fed. Reg. 41172, that will allow contractors that are subject to the requirement for audit of key business systems (more than $50 million annually of contracts requiring cost or pricing data) to self-certify that their key business systems are adequate and to elect to use DOD-approved third-party auditors to periodically validate those same systems. The comment period ends on September 15, 2014.

Government Contracts Quarterly Update
July 2014
Proposed Rule Focuses on Audit of
Business Systems, May Expedite and
Streamline Process
On July 15, the Department of Defense (“DOD”) released a
proposed rule, 79 Fed. Reg. 41172, that will allow contractors that
are subject to the requirement for audit of key business systems
(more than $50 million annually of contracts requiring cost or
pricing data) to self-certify that their key business systems are
adequate and to elect to use DOD-approved third-party auditors to
periodically validate those same systems. The comment period
ends on September 15, 2014.
The Defense Contract Audit Agency (“DCAA”) is tasked with
examining accounting and billing, estimating, material
management, and accounting systems, while the Defense
Contract Management Agency (“DCMA”) reviews purchasing,
government property and management, and earned value
management systems. Collectively, these systems comprise the
key business systems that give rise to the generation of cost or
pricing data that covered contractors are required to deliver in
support of their offers. The proposed rule would leave the DCMA
review process largely unchanged (DCMA is not as inundated with
other audit work as is DCAA).
The proposed rule could be a net positive for contractors (and for
DCAA, whose auditors are years behind in their review of incurred
cost submissions). The proposed rule, if adopted, should ease the
audit load that would otherwise be imposed on DCAA and thereby
expedite the process and time frame for conducting business
systems audits, thus giving contractors greater control over how
and when those reviews are completed.
There is a dark side, however, to the proposed rule: contractors
who opt to self-certify and rely upon outside audit firms will be
required to provide to those auditors (and therefore, to the
government) their internal audit work papers and related materials
generated in connection with the self-certifications. In contrast,
production of those same papers would not be required of
contractors in a DCAA review. The accompanying requirement
for delivery of records could give rise to creation of new or
different work papers by personnel who operate outside the
accounting and finance functions as a way of walling off those
routine but nonetheless sensitive functions from the business
systems review (operating much like an ombudsman). In other
words, even with additional requirements for record
transparency, contractors and their advisors will likely evolve
the finance and accounting functions to avoid having to produce
pure accounting and finance records, while still complying with
the requirement for delivery of records that substantiate the
adequacy of business systems.
D.C. Circuit Extends Attorney-Client
Privilege to Internal Compliance
Investigations
In recent years, numerous trial courts have ruled that
communications between counsel and corporate executives or
other personnel are protected by privilege only if the “primary
purpose” of the exchange was to request or furnish legal
advice, thereby potentially exposing to discovery
communications in connection with the investigation of
regulatory and compliance matters. See, e.g., United States v.
ISS Marine Servs., Inc., 905 F. Supp. 2d 121, 128 (D.D.C.
2012) (but for the request for legal advice, the exchange with
counsel could not qualify for privilege). Recognizing that
companies often undertake actions for multiple overlapping
reasons, the D.C. Circuit rejected the “but for” test, concluding
that the attorney-client privilege applies “[s]o long as obtaining
or providing legal advice was one of the significant purposes of
the internal investigation.” In re Kellogg Brown & Root, Inc., –
F.3d –, 2014 WL 2895939, at *4 (D.C. Cir. 2014). In other
words, the request for legal advice need not be the primary
purpose of the communication.
• Proposed Rule Focuses on Audit of
Business Systems, May Expedite and
Streamline Process
• D.C. Circuit Extends Attorney-Client
Privilege to Internal Compliance
Investigations
• Executive Order 13665 Allows Agencies to
Terminate Contracts If Contractors
Retaliate Against Employees Who
Disclose Compensation
• Proposed DOD Rule Expands Contractors’
Risk of Personal Conflicts of Interest
• DOD’s Restrictions on Counterfeit Parts
Rule Is Limited to Electronic Parts, but More
Changes Are Expected
• DOD’s New FOCI Rules Present New
Challenges to Contractors with Foreign
Connections
• Would-Be Service Contractors Face
Exposure of up to $10,000 Penalty per Day
under HHS Contracts
• GAO Decides That Small Business Joint
Venture Proposals Do Not Require SBA Pre-
Approval
• Baker Team Secures Arbitration Award for
Wrongful Termination of Subcontract
• Legislative and Regulatory Updates
www.bakerlaw.com
The Government Contracts Quarterly Update is published by BakerHostetler’s Government Contracts Practice Group to inform
our clients and friends of the latest developments in federal government contracting.
This Quarterly Update is for informational purposes only and does not constitute specific legal advice or opinions. Such
advice and opinions are provided by us only upon engagement with respect to specific factual situations. This communica-
tion is considered attorney advertising.
The KBR decision is especially important to government
contractors because the original controversy arose in
connection with a government contract. In KBR, a former
employee advanced numerous allegations of improper
conduct by KBR. KBR conducted an internal investigation,
overseen by in-house attorneys, into many of the alleged
improprieties. The investigation was commenced in
fulfillment of the company’s Code of Business Conduct,
which was, in turn, promulgated to comply with Department
of Defense contracting regulations requiring internal control
systems. See 48 C.F.R. §§ 203.7000–203.7001(a). Before
the lower court, the qui tam relator endeavored to compel
production of investigative materials and files prepared by
counsel and communicated to management. The district
court found that KBR was obligated to conduct an
investigation regardless of its need for legal advice, and
therefore, the subject communications could not qualify for
the privilege. In reversing the lower court, the D.C. Circuit
eliminated what it viewed as a “false dichotomy,” thereby
restoring the safe haven that has always been provided
under the attorney-client privilege. This holding allows
businesses to plan and execute internal investigations
without the risk of exposing to discovery all of their
investigative communications with counsel, thereby
preserving the need for and provision of candor between
client and counsel.
Executive Order 13665 Allows Agencies
to Terminate Contracts If Contractors
Retaliate Against Employees Who
Disclose Compensation
On April 8, President Obama signed Executive Order
13665, aimed at combating employer policies restricting or
prohibiting employees from being able to discuss
compensation with colleagues, thereby curtailing the
practice of preventing employees from discussing
compensation data (such as co-workers talking about their
respective wage rates). The Executive Order, effective on
April 8, 2014, allows agencies to terminate contracts where
the contractor discriminates against or penalizes employees
who discuss among themselves their compensation data.
The National Labor Relations Act (“NLRA”) grants
employees the right to discuss the terms and conditions of
their employment for the purpose of collective bargaining,
and prohibits employers from interfering with that right.
29 U.S.C. §§ 157-58. The NLRA does not, however,
prescribe serious penalties for employer violations; the
National Labor Relations Board (“NLRB”), which has
jurisdiction over employment disputes arising under the Act,
may order injunctive and equitable relief—including back
pay and reinstatement for wrongfully terminated
employees—but may not issue punishments such as fines
for employer violations. 29 U.S.C. § 160(c).
Given that somewhat incomplete framework, employers
routinely restrict employees from discussing compensation
with one another.
With limited exceptions, the Executive Order applies to
all government contractor employees, not just the
nonsupervisory employees covered by the NLRA. Although
the Order is technically in effect, the Department of Labor
must propose implementing regulations by September 15,
2014. Employers should take the time now to review and
revise their policies and procedures to comply with the
Order’s prohibitions and participate in the public comment
process once DOL releases the new rules.
Proposed DOD Rule Expands
Contractors’ Risk of Personal Conflicts of
Interest
Currently, the FAR includes some coverage to require
contractors to identify personal conflicts of interest (“PCI”) in
connection with contractor personnel who work on
“acquisition function[s] closely associated with inherently
governmental functions,” such as developing the work
specifications to be included in a solicitation. FAR 3.1101.
Contractors are required to maintain procedures to identify
potential PCIs, including requiring internal employee
disclosure of financial interests and managing work
assignments to ensure that covered employees are only
assigned to conflict-free projects.
On April 2, the FAR council proposed a new rule expanding
the scope of the PCI rules. 79 Fed. Reg. 18503. The
proposed rule does not materially change the existing rules,
but it does expand the definition of “covered employee” to
include those folks performing any work that is closely
associated with inherently governmental functions, such as
law enforcement activities, intelligence operations, or internal
policy development, FAR 7.503(c), and those working on
service contracts, FAR 37.104. The expanded coverage
scope is not limited to just the acquisition functions. The new
rule does not apply to commercial items or to contracts
valued below the simplified acquisition threshold ($150,000).
Even so, the FAR council estimates the new rule could affect
over 28,000 contract actions (e.g., actions resulting in a contract,
including actions for additional supplies or services outside the
existing contract scope) annually, requiring many contractors to
now implement PCI procedures for the first time.
The public comment period ended on June 2. Numerous
business groups (i.e., the U.S. Chamber of Commerce,
Aerospace Industries Association, and Professional Services
Council) commented in opposition to the new requirements.
DOD’s Restrictions on Counterfeit Parts
Rule Is Limited to Electronic Parts, but
More Changes Are Expected
On May 6, DOD issued the final version of its counterfeit
parts rule, 79 Fed. Reg. 26,092. See Baker’s July 2013
Quarterly Update. Responding to concerns of ambiguity and
overbreadth, the Final Rule is limited strictly to counterfeit
electronic parts and adds an intent requirement that the part
be “knowingly mismarked, misidentified, or otherwise
misrepresented” as a precondition for finding contractor
liability.
The Final Rule, also effective May 6, 2014, covers all prime
contractors subject to the Cost Accounting Standards,
requiring them to implement as part of their purchasing
system policies that are designed to prevent the introduction
of counterfeit parts into the supply chain. Among other things,
this requires imposition of flow-down clauses to ensure that
lower tier subcontractors also take preventative measures
against incorporation of counterfeit electronic parts into their Page 2
supply chains. Covered contractors whose purchasing
systems are found to be deficient face the possibility of having
payments withheld.
Even though DOD agreed to narrow the scope of its final rule,
contractors must remain vigilant. The FAR council released a
proposed rule on June 10, 2014 that will (if implemented as
final) expand civilian contractor responsibilities to include
proactive measures to protect against the incorporation of
counterfeit and nonconforming items. 79 Fed. Reg. 33164.
But, unlike DOD’s final rule, the proposed FAR rule will apply
to any item supplied by any contractor that is subject to FAR.
The comment period closes on August 11.
DOD’s New FOCI Rules Present New
Challenges to Contractors with Foreign
Connections
On April 9, DOD issued an interim final rule formally
implementing National Industrial Security Program (“NISP”)
regulations for companies subject to foreign ownership,
control, or influence (“FOCI”), 79 Fed. Reg. 19467, codified at
32 C.F.R. Part 117. The rule replaces the informal agency
guidance that was available through individual DOD staff
contacts and high-level provisions in the NISP Operating
Manual (“NISPOM”).
A company is considered to be under FOCI when a foreign
interest has “the power . . . to direct or decide matters affect-
ing the management or operations of the company in a
manner that may result in unauthorized access to classified
information or may adversely affect the performance of
classified contracts.” 32 C.F.R § 117.56(b)(1); see also 79
Fed. Reg. 19472. Although various arrangements may
constitute FOCI, including contractual arrangements, the
NISP has heretofore been concerned primarily with ownership
arrangements and the attendant right to control corporate
actions. The new rule allows DSS to find FOCI when the
foreign holder of an ownership or voting interest of greater
than five percent cannot be adequately identified. 32 CFR
§ 117.56(b)(3)(v). This provision may create significant
complications for complex investment vehicles such as hedge
funds, which often do not readily disclose their underlying
investors.
The new rule also clarifies the relationship between the review
of foreign acquisitions conducted by the Committee on
Foreign Investment in the United States (“CFIUS”) and the
NISP procedures. 32 C.F.R. § 117.56(b)(14); see also 79
Fed. Reg. 19473. Although the two procedures remain
separate, the rule explains that CFIUS and DSS will
coordinate their reviews and share information, increasing the
importance of a coordinated regulatory strategy for companies
submitting investments from or acquisitions by foreign
interests for government review.
Would-Be Service Contractors Face
Exposure of up to $10,000 Penalty per
Day under HHS Contracts
On May 12, the U.S. Department of Health and Human
Services (“HHS”) published notice of a proposed rule to
amend the civil monetary penalty (“CMP”) rules of the Office
of Inspector General (“OIG”). As part of an overhaul of 42
C.F.R. Part 1003, the OIG proposed several updates to codify
changes made by the Patient Protection and Affordable Care
Act (“PPACA”). The proposed rule would (if implemented)
expand the range of conduct subject to CMPs,
assessments, and exclusions to include:
• Failing to grant OIG timely access to records upon
reasonable request;
• Ordering or prescribing treatments likely to be financed
by federal programs from which one is excluded;
• Making or causing to be made any false statement,
omission, or misrepresentation in a bid, contract, or
application;
• Failing to report and return known overpayments; and
• Making or using false records and statements to
support a fraudulent claim.
The proposed rule would also clarify the methodology used
for calculating penalties and assessments for utilization of
excluded employees, among other things. Of significant
potential concern is the proposed application of a default
assessment of $10,000/day as a penalty for failing to return
overpayments within 60 days of their identification.
The commenting period closed on July 11.
GAO Decides That Small Business Joint
Venture Proposals Do Not Require SBA
Pre-Approval
On May 29, the GAO ruled that joint venture agreements do
not require approval from the Small Business Administration
(“SBA”) before submitting a proposal for solicitations issued
pursuant to the SBA’s 8(a) set-aside program. See BGI-
Fiore JV, LLC, B-409520 (May 29, 2014). NASA conceded
during the protest that the SBA’s regulations do not require
pre-proposal certification, see 13 C.F.R § 124.513, but it
nonetheless argued that the FAR permits agencies to
impose more stringent standards than those required by the
SBA. FAR 52.219-18. NASA, hoping to avoid evaluation of
proposals that might later be deemed ineligible for selection,
rejected all proposals submitted by joint ventures that did
not possess SBA approval at the time of their proposal
submission. The GAO disagreed with NASA’s views, noting
that the SBA’s regulations only require a joint venture
agreement to be approved prior to the awarding of the
contract.
Of course the GAO’s decision makes complete sense from
a savings perspective. Why should SBA be required to
consider all joint ventures before bids are submitted when it
really need consider and approve only the one joint venture
that is selected for award?
Baker Team Secures Arbitration Award
for Wrongful Termination of Subcontract
On July 9, a panel of three arbitrators issued an arbitration
decision awarding Baker’s client, a small business under
subcontract to furnish nursing personnel at the Tripler Army
Medical Center (“TAMC”), approximately $2 million for the
prime contractor’s wrongful termination of the subcontract
18 months before the agreed-upon expiration date. The
award capped a 15-month arbitration proceeding that
culminated in a 10-day hearing.
Page 3
Code
Section Agency Regulation Description
Lastest
Action
Effective
Date
48 CFR Parts
1, 4, 12, 22,
and 52
DOD,
GSA,
NASA
To amend the FAR to require the use of Commercial and Government Entity
(“CAGE”) codes, including North Atlantic Treaty Organization codes (“NCAGE”)
for foreign entities, for awards valued at greater than the micropurchase thresh-
old
Final Rule 11/1/2014
48 CFR Parts
4, 42, and 52
DOD,
GSA,
NASA
To implement the Consolidated Appropriations Act, 2014, by amending the FAR
to revise the clause on Recovery Act reporting procedures and repeal the report-
ing requirements of the American Recovery and Reinvestment Act of 2009
Final Rule 5/30/2014
48 CFR Parts
31 and 52
DOD,
GSA,
NASA
To implement a section of the National Defense Authorization Act of 2012 by
amending the FAR to expand the application of the senior executive compensa-
tion benchmark to a broader group of contractor employees on contracts award-
ed by DOD, NASA, and the Coast Guard
Final Rule 5/30/2014
48 CFR Part
42
DOD,
GSA,
To amend the FAR to implement statutory changes expediting the review and
dissemination of past performance evaluations
Final Rule 7/1/2014
Bill
Number Sponsor Legislation Description
Last
Action Status
H.R. 4394 Grayson A bill to prohibit the awarding of contracts to contractors responsible for delayed
openings of Veterans Affairs facilities
4/3/14 Referred to
Committee
S. 2247 McCaskill A bill to prohibit awarding contracts or grants above the simplified acquisition
threshold unless the prospective awardee certifies that it has no seriously delin-
quent tax debts
4/10/14 Referred to
Committee
S. 994 Warner A bill to enable taxpayers and policymakers to track federal spending more effec-
tively by simplifying reporting requirements for entities receiving federal funds
5/9/14 Signed by
President
S. 2334 King A bill to amend the Small Business Act and Title 38 of the U.S. Code to provide
for a consolidated definition of a small business concern owned and controlled by
veterans
5/15/14 Referred to
Committee
S. 2391 Murphy A bill to amend the Buy American Act and certain other laws to narrow excep-
tions to domestic sourcing requirements
5/22/14 Referred to
Committee
H.R. 4729 Grayson A bill to require debarment of persons convicted of fraudulent use of “Made in
America” labels
5/22/14 Referred to
Committee
S. 1681 Feinstein A bill to authorize intelligence activities for fiscal year 2014 and to require im-
provements in intelligence community security clearance procedures, stronger
contractor protection of classified information and rapid reporting of unauthorized
breaches of that information
6/12/14 Passed by
Senate
H.R. 4876 Carson A bill to amend the Small Business Act to provide for contracting preferences and
other benefits for emerging business enterprises
6/17/14 Referred to
Committee
H.R. 4920 Tiberi A bill to amend the Social Security Act to require state licensure and perfor-
mance guarantees for entities submitting bids under the Medicare durable medi-
cal equipment, prosthetics, orthotics, and supplies (“DMEPOS”) competitive ac-
quisition program
6/19/14 Referred to
Committee
Page 4
Legislative Updates
Regulatory Updates
About BakerHostetler
BakerHostetler, one of the nation’s largest law firms, represents
clients around the globe. With offices coast to coast, our more
than 800 lawyers litigate cases and resolve disputes that poten-
tially threaten clients’ competitiveness, navigate the laws and
regulations that shape the global economy, and help clients
develop and close deals that fuel their strategic growth. At
BakerHostetler we distinguish ourselves through our commit-
ment to the highest standard of client care. By emphasizing an
approach to service delivery as exacting as our legal work, we
are determined to surpass our clients’ expectations.
BakerHostetler’s Government Contracts Practice Group consists
of more than a dozen attorneys with extensive experience in
government contracts, including former government attorneys
from the Justice Department, SEC, and USPTO. Working closely
with the firm’s other practice groups, including the Intellectual
Property, Labor, International Trade, FDA, and White Collar
groups, among others, the Government Contracts Practice
Group represents clients on a wide variety of government
contract matters and cases.
Why BakerHostetler’s Government Contracts
Practice Group?
• Seasoned, experienced team with a deep bench.
• Several attorneys with technical and engineering
backgrounds.
• Former government attorneys.
• Outstanding client service and responsiveness.
• Competitive value-driven rates and fee arrangements.
Hilary S. Cairnie
Partner, Washington, D.C.
202.861.1668
hcairnie@bakerlaw.com
Kelley P. Doran
Partner, Washington, D.C.
202.861.1661
kdoran@bakerlaw.com
Kelley Doran has focused on
government contracts counseling,
contract negotiation, and litigation for
over fifteen years. Mr. Doran’s
practice includes representing a
broad array of commercial item,
defense, and homeland security
contractors that sell products and
services to the federal, state, and
local governments. He has worked
with product and service companies
in numerous industries, including
biodefense and life sciences,
environmental remediation, home-
land security, information technolo-
gy, and nanotechnology.
Hilary Cairnie is the head of the firm’s
Government Contracts Practice. He
focuses on public contract law,
encompassing virtually all aspects
including contract formation,
performance, administration, and
enforcement controversies at the
federal and state levels. With two
engineering degrees and several years
of experience working as an engineer
for various companies, Mr. Cairnie uses
his unique technical background to
represent clients involved in aerospace,
automotive, shipbuilding, transportation,
construction, software, medical and
healthcare, engineering, and research
and development endeavors, among
others.
This Quarterly Update is for informational purposes only and does not constitute specific legal advice or opinions. Such advice and opinions are
provided by us only upon engagement with respect to specific factual situations. This communication is considered attorney advertising.
www.bakerlaw.com
Page 5

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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